and Their Responsibilities for Trust Fund Taxes
JULY 2007 - Accountants
are often encouraged by their employers to serve as treasurers or
board members for both taxable and tax-exempt organizations. While
service to the community is an admirable goal, accepting such a
position may bring certain legal responsibilities with regard to
the withholding of Social Security, Medicare, and federal income
taxes from employees of the organization. The amounts withheld from
employees’ salaries are considered to be held “in trust”
and must be remitted to the federal government on behalf of the
employees. If an organization fails to remit the taxes to the government,
however, the IRS has the authority to assess a 100% penalty against
certain responsible persons within the organization. This article
examines the circumstances in which an outside director or a volunteer
for a tax-exempt organization is potentially subject to the penalty.
collected from employees’ wages are considered to be held
by the employer in trust for the United States [IRC section 7501(a)].
Once withheld, the employee receives credit from the IRS regardless
of whether the amount is ever remitted to the government [Treasury
Regulations section 1.31-1(a)]. In situations where withholding
taxes are not paid over to the government by the employer, the
IRS may seek collection from any person within the organization
who is responsible for the collection, truthful accounting for,
and payment of the trust fund taxes, and who willfully failed
to remit the taxes to the government [IRC section 6672(a)].
to tax-exempt organizations, the penalty will not be assessed
against an unpaid voluntary board member as long as the individual:
1) is serving solely in an honorary capacity; 2) does not participate
in the daily financial operations of the organization; and 3)
does not have knowledge of the failure of the payment of the tax.
The preceding will not apply, however, if it results in no person
within the organization being liable for the penalty [IRC section
If a volunteer
within a tax-exempt organization cannot meet the requirements
of IRC section 6672(e), or if the individual serves as an outside
director on the board of a taxable corporation, then the IRS may
assess the penalty if two criteria are met:
- The individual
must be required to collect, truthfully account for, and pay
over the tax. Such an individual is commonly referred to as
a “responsible person” [Slodov v. U.S.,
78-1 USTC para. 9447 (USSC 1978)].
- It must
be established that the person “willfully” failed
to collect, account for, or pay over the tax owed.
Is a ‘Responsible Person’
the IRC nor the Treasury Regulations define who is considered
a responsible person, the interpretation has been left up to the
courts, which have taken a very broad view of the issue. A responsible
person has been described as an individual who:
the effective power to pay the tax [Howard v. U.S.,
83-2 USTC para. 9528 (CA-5, 1983)];
significant control over the company’s finances or general
decision-making [Hochstein v. U. S., 90-1 USTC para.
50,205 (CA-2, 1990)]; or
disbursements of funds and the priority of payments to creditors
in preference of withholding obligations [Gephart,
87-1 USTC para. 9319 (CA-6, 1987)].
this determination, the courts attempt to balance all of the facts
and circumstances surrounding an individual’s authority
within the company. Specific factors held to be relevant are whether
the individual: 1) is an officer or member of the board of directors;
2) owns shares or possesses an entrepreneurial stake in the company;
3) is active in the management of day-to-day affairs of the company;
4) has the ability to hire and fire employees; 5) makes decisions
regarding which, when, and in what order outstanding debts or
taxes will be paid; 6) exercises control over daily bank accounts
and disbursement records; and 7) has check-signing authority [Thomas
v. U.S., 94-2 USTC para. 50,607 (CA-7, 1994)].
important points should be kept in mind:
- No single
factor above will cause an individual to be classified as a
responsible person. The courts attempt to determine whether
the person was connected closely enough with the business to
prevent the nonpayment of tax from occurring [Bowlen v.
U.S., 92-1 USTC para. 50,098 (CA-7, 1992)].
control does not mean exclusive control [Mazo v. U.S.,
79-1 USTC para. 9284 (CA-5, 1979)] or absolute control (Gephart).
there can be several responsible persons within the company. For
example, in Carter v. U.S. [89-2 USTC para. 9446 (S.D.
N.Y., 1989)], the taxpayers were officers and directors of a not-for-profit
corporation. The minutes of board meetings indicated that the
directors were involved in routine business concerns such as corporate
funding, bookkeeping, salaries, and the hiring and firing of employees.
The directors had check-signing authority and invoices were attached
to checks presented to the board for approval. Payroll checks
were prepared by the City of New York as a condition to city funding,
using a facsimile signature.
argued that they became involved in corporate business only when
high-level employees were concerned. However, the board minutes
showed that the board dealt with such routine matters as the hiring
of a secretary/receptionist, the work performed by the data clerk-typist,
the conditions of the books and records, and the corporation’s
tax problems. Given this level of involvement by the directors
in the day-to-day activities of the corporation, the court ruled
that all of them were responsible persons.
to Responsible Person Classification
the authority to pay the delinquent taxes. As noted
earlier, in determining who is considered to be a responsible
person, the courts attempt to balance the facts and circumstances
surrounding an individual’s authority within the company
to pay the taxes. The Federal Circuit Court of Appeals addressed
this issue with respect to unpaid outside directors in Godfrey
v. U.S. [84-2 USTC para. 9974 (CA-FC, 1984)].
the chairman of the board of a taxable corporation that was experiencing
significant financial difficulty. He was not authorized to sign
checks, received no salary as chairman, played no role in the
preparation of the company’s payroll, and never signed any
payroll forms. As a director, Godfrey participated in electing
officers, hired or approved the hiring of top-level consultants,
and authorized the borrowing by officers on behalf of the corporation.
He was also instrumental in negotiating a critical recapitalization
agreement with a potential investor.
court had held that Godfrey’s status as chairman, and the
respect and deference accorded that status, amounted to the ultimate
authority to control the payment of withholding taxes, and resulted
in Godfrey being considered a responsible person for purposes
of IRC section 6672. Reversing on appeal, the Federal Circuit
Court of Appeals observed that there had never been a case where
an outside director of a publicly held corporation had been held
to be a responsible person who: 1) neither signed nor had authority
to sign checks, 2) did not participate in the day-to-day fiscal
management of the corporation, 3) did not control the payroll,
4) did not determine which creditors would be paid, and 5) did
not own a significant fraction of the company’s voting stock.
it was an important consideration that Godfrey was the most important
individual in the business affairs of the company, it was not
sufficient to make him a responsible person. The crucial inquiry
required by the statute was whether Godfrey held the substantive
power to compel or prohibit the allocation of corporate funds
with respect to the trust fund taxes. Given that no evidence was
provided that Godfrey had exercised control of the collection,
accounting for, and payment of the trust fund taxes, the court
ruled that he was not a responsible person. The court also noted
that knowledge of nonpayment of the taxes was a factor used to
determine willfulness but was irrelevant in considering the question
of whether he was a responsible person.
Bill of Rights 2 (P.L. 104-168), which added subsection 6662(e)
in 1997, addressed the “authority to pay” issue for
volunteers to tax-exempt organizations. In what appears to be
intended as a safe harbor provision, a volunteer will not be considered
to have the authority to pay withholding taxes if the volunteer’s
position is solely honorary and the volunteer is not involved
in the company’s day-to-day operations. These criteria were
specifically addressed in Holmes v. U.S. [2004-2 USTC
para. 50,301 (S.D. Tex., 2004)].
in question, Holmes, was an unpaid director and chairman of the
board of a parochial school that was experiencing financial difficulties.
All school checks required two signatures. Holmes, Floyd (another
director), and the school’s administrator were signatories.
claimed that he signed checks only when others were unavailable.
When Holmes discovered that the withholding taxes had not been
paid, he suggested cutbacks to free up the necessary funds. Holmes
claimed that the board rejected his ideas at the insistence of
the school’s administrator.
concluded that Holmes had enough authority within the school to
be considered a responsible person. He knew of the unpaid taxes
and he signed several checks to some of the school’s creditors
instead of paying the withheld taxes. The court further stated
that Holmes was not immune from liability because he was a volunteer
for the school. His titles, positions, and jobs were not honorary,
and he was involved in the school’s financial operations.
of Holmes, it is likely that most board positions for
tax-exempt organizations would not be considered honorary by the
courts. The duties and responsibilities of the board members,
and especially of a treasurer, are generally outlined in detail
in an organization’s bylaws. Thus, the safe harbor would
appear to be of little value.
of authority. Taxpayers have also attempted to avoid
responsible person classification by asserting that another individual
within the company had been directed to pay the tax. The courts
have generally ruled, however, that if an individual had sufficient
authority in the company such that the tax delinquency could have
been avoided, delegation of responsibility will not relieve an
otherwise responsible person of liability [e.g., Thomsen v.
U.S., 89-2 USTC para. 9575 (CA-1, 1989)].
v. U.S. [96-1 USTC para. 50,114 (E.D. N.Y., 1996)], the chairman
of the board of directors of a not-for-profit organization attempted
to avoid responsible person classification by claiming to have
delegated it to the executive director and the in-house accountant.
an unpaid volunteer to the organization, had express authority
to sign checks and tax returns, sign loans, approve use of the
organization’s funds, and terminate the executive director.
Although authority to oversee the preparation of tax returns,
the keeping of records, the payment of wages, and the withholding
and payment of taxes rested with the board, the duties were delegated
to the executive director and the accountant.
ruled that the law does not permit individuals to delegate their
authority to another person within the organization and blindly
trust that the duties will be carried out. Wright was entrusted
with the duty to make sure that the organization’s funds
were properly spent and that its financial and tax obligations
were met. The signing of checks and loan documents inserted him
into the organization’s day-to-day operations. Wright’s
position on the board was much more than honorary.
from higher authority—control of funds. Another
argument that has been used by taxpayers in an attempt to avoid
the penalty is that they lacked authority because they were ordered
not to pay the taxes by an individual with greater authority within
the organization (i.e., they were not in control of the funds).
the taxpayer served as director, minority shareholder, and executive
vice president of the corporation. Howard also managed the corporation’s
day-to-day operations. During a period of financial difficulty,
the president, who was also the majority stockholder of the corporation,
instructed Howard not to pay the withholding taxes to the government.
recognized the quandary facing Howard. If he had paid the taxes,
thus fulfilling his obligation to the government, he would have
been fired. An unsympathetic court noted that: “Faced with
the possibility of leaving the frying pan with only minor burns,
the taxpayer chose instead to stay on in the vain hope of avoiding
the fire. While we appreciate the difficulty of his position,
we cannot condone his abdication of the responsibility imposed
upon him by law.” Howard was held liable for the unpaid
were reached in Gephart, Roth v. United States [86-1
USTC para. 9172 (CA-11, 1986)], Lubetzky v. U.S. [2005-1
USTC para. 50,207 (CA-1, 2005)], and Brounstein v. U.S.
[93-2 USTC para. 50,512 (CA-3, 1992)]. Although the previous court
decisions are very troubling for taxpayers facing orders from
someone of higher authority within the organization, the Tenth
Circuit Court of Appeals has taken a potentially more favorable
view. In Jay v. United States [89-1 USTC para. 9154 (CA-10,
1989)], the court held it was possible that a supervisor’s
control over an employee’s actions might be sufficient to
render that employee not a responsible person. According to the
Tenth Circuit, the critical factor is to determine whether the
person possesses a sufficient degree of authority over corporate
v. United States [89-2 USTC para. 9449 (N.D.Ill.)] applies
the Tenth Circuit’s rationale in ruling that the taxpayer
was not a responsible person. In Graunke, the taxpayer,
who had completed two years of business college, was assessed
a responsible person penalty by the IRS. Graunke had completed
nine quarterly federal withholding tax returns (Form 941) during
the period in question. He signed three of the returns; five were
signed by the owner of the company, and one was left blank. On
one of the returns, Graunke indicated his title was “comptroller.”
check-signing authority on the company’s bank account, but
several employees testified that the owner decided which creditors
would be paid. It was clear from the records that there was never
enough money to pay all creditors, meet the payroll, and pay withholding
taxes. Graunke spent two days a week at the company and was not
in charge of day-to-day operations.
the owner of the liability for withholding taxes. The owner indicated
that he intended to obtain a loan on his motel properties to pay
the withholding taxes and that Graunke should not pay them until
the financing was completed. After realizing that new financing
had not been obtained, Graunke refused to sign the tax returns.
testified at trial that he was responsible for the failure to
remit federal withholding taxes and that all financial and employment
decisions were his responsibility. The company’s CPA also
testified that the owner made all the financial decisions and
decided who would and would not be paid by his business.
Court ruled that Graunke was not a responsible person within the
meaning of IRC section 6672. Basing its decision on Jay,
the court stated that it did not appear that the law has gone
so far as to require that a person must disregard check-writing
instructions in order to avoid liability. Rather, the focal point
should be whether the taxpayer “possessed a sufficient degree
of authority over corporate decision-making to make him a responsible
person.” The evidence in Graunke showed that the owner made
all financial decisions and strictly controlled the payment of
creditors. There was no evidence that Graunke could have
or would have, in the short time he was employed, overridden the
owner’s payment decisions. Also unclear was whether Graunke
was even aware of how the financial matters would be conducted.
Graunke’s only responsibilities were accounting matters
and bill-paying at the direction of the owner.
Graunke was not in a not-for-profit setting, treasurers
or voluntary bookkeepers could potentially face the same type
of pressure from a not-for-profit entity’s board or chairman.
The Graunke decision may serve as some comfort to these
volunteers. However, it should be noted that had Graunke lived
outside of the Tenth Circuit’s jurisdiction, it is probable
that the IRS would have prevailed.
criterion for assessment of the responsible person penalty is
that the individual’s failure to ensure that withholding
taxes were remitted must have been willful. The willfulness criterion
has been described as a “voluntary, conscious and intentional
decision to prefer other creditors over the Government”
[Burden v. U.S., 73-2 USTC para. 9547 (CA-10, 1973)].
Willfulness in this context requires only that the responsible
person knew that the company was required to pay withholding taxes
and that company funds were being used for other purposes [e.g.,
U.S. v. Rem, 94-2 USTC para. 50,357 (CA-2, 1994)]. The IRS
is not required to establish that the person deliberately sought
to defraud the government (Thomas).
a number of defenses that a taxpayer can raise with regard to
the willfulness criterion that have met with varying success in
cause. Taxpayers have often argued that the willfulness
criterion has not been met due to extenuating circumstances that
resulted in the nonpayment of the trust fund taxes. Seven circuit
courts of appeal have held that the reasonable-cause exception
is not valid. Any payment to other creditors, including the payment
of net wages to the corporation’s employees, that is made
with knowledge that employment taxes are due and owing to the
government, constitutes a willful failure to pay taxes as a matter
of law [e.g., Monday v. U.S., 70-1 USTC para. 9205 (CA-7,
1970)]. It is no defense that the corporation was in financial
distress and that funds were spent to keep the corporation in
business with an expectation that enough revenue would later become
available to pay the government [Emshwiller v. United States,
77-2 USTC para. 9744 (CA-8, 1977)]. Nor is it a defense that a
taxpayer would be terminated if he signed a check to the IRS without
the express authority of a superior (Gephart).
have held that in very limited circumstances, reasonable cause
may be used as a defense against willfulness. The Tenth Circuit
Court of Appeals provides that the reasonable-cause exception
may apply if the taxpayer can prove that reasonable efforts were
made to protect the trust fund taxes but those efforts were frustrated
by circumstances outside of the taxpayer’s control [Finley
v. U.S., 97-2 USTC para. 50,613 (CA-10, 1997)]. Unfortunately,
there are no cases of widespread application where the reasonable-cause
exception has been met. Factors not meeting reasonable-cause criteria
- The delegation
of the responsibility to another person [Lawrence v. U.S.,
69-1 USTC para. 9392 (N.D. Tex., 1969)];
- The expectation
that the financial condition of the company would improve [Paisner
v. O’Connell, 62-2 USTC para. 15,439 (D.R.I., 1962)];
- The assumption
that the government would satisfy its tax claims out of another
fund [Cash v. IRS, 65-1 USTC para. 9428 (CA-5, 1965)];
- The reliance
on statements prepared by the accountants [Newsome v. U.S.,
70-2 USTC para. 9504 (CA-5, 1970)]; and
- The taxpayer’s
misunderstanding of the legal withholding requirements [Sorenson
v. U.S., 75-2 USTC para. 9694 (CA-9, 1975)].
of knowledge. Another defense that has been used
against the willfulness criterion is that the person was unaware
the tax had not been remitted by the company. Although the IRS
has generally taken the position that knowledge of nonpayment
is irrelevant, the courts have consistently held that when the
taxpayer believed that payment had been made, the willfulness
criterion had not been met [e.g., U.S. v. Leuschner,
64-2 USTC para. 9742 (CA-9, 1964)]. The lack-of-knowledge defense
has not been upheld by the courts in situations where a person
should have known there was a serious risk that withholding taxes
were not being paid and where the person was in a position to
easily discover the nonpayment (Wright), or in situations
where there was a reckless disregard of a known risk that nonpayment
Circuit in Rem identified three factual scenarios that
would constitute a reckless disregard of a known risk of nonpayment
and would result in the willfulness criterion being met. The three
scenarios are: 1) “reliance upon the statements of a person
in control of the finances when the circumstances show that the
responsible person knew the person to be unreliable; 2) failure
to investigate or to correct mismanagement after having notice
of nonpayment of withholding taxes; and 3) knowing that the business
was in financial trouble and continuing to pay other creditors
without making reasonable inquiry as to the status of the withholding
in Giles v. U.S. [94-2 USTC para. 50607 (CA-7, 1994)],
Percy Giles was the volunteer treasurer and ex-officio chairman
of the finance and planning committee of Mile Square, a not-for-profit
community health clinic. Giles had the opportunity to attend meetings
where corporate officers discussed Mile Square’s financial
problems, and on occasion he signed checks. He was also responsible
for distributing packets to the committee members that detailed
Mile Square’s receipts and expenditures. Giles was also
an alderman to Chicago’s 37th Ward and worked about 12 hours
a day in that capacity. As a result of Giles’ busy schedule,
he was unable to attend many board meetings. When he ran the finance
committee meetings, he merely followed the agenda prepared by
Mile Square’s CEO. Giles claimed that he didn’t know
of the unpaid withholding taxes and that he had been too busy
to read the financial reports. The court ruled that even if Giles
did not know about the failure to pay withholding taxes, it would
have been relatively easy for him to discover by simply reviewing
the financial reports provided to him. The verdict was upheld
on appeal to the Seventh Circuit Court of Appeals.
have ruled that once a responsible person knows that the individual
to whom he has designated responsibility for payment of withholding
taxes has failed to pay them in the past, reliance on that person
will generally constitute willfulness [e.g., Denbro v. U.S.,
93-1 USTC para. 50,177 (CA-10, 1993)]. The Federal Circuit Court
of Appeals has applied a more restrictive interpretation, stating
that as long as the responsible person ensures that any past failure
to make payment has been rectified, he has no affirmative duty
to ensure that future payments will be made. In other words, the
responsible person must have actual knowledge of a current delinquency
to establish a duty to act (Godfrey).
About Collection Procedures
misconception about the responsible person penalty is that the
IRS must try to recover the unpaid taxes from the company before
assessing a penalty against persons within the company. In reality,
the responsible persons are both jointly and severally liable.
Although the IRS’s policy is to collect only the amount
due from any group of jointly liable persons (Internal Revenue
Manual, subsection 4784), IRS procedure is to seek a judgment
against each party for the full amount due. If more than 100%
of the tax is ultimately collected, a refund is issued for the
excess. The refund will not be issued until the expiration of
the statute of limitations for claims for a refund by the taxpayer,
or until the case has been adjudicated. Unfortunately, this process
may take several years.
section 6672(d), a responsible person who pays more than his share
of the trust fund tax penalty has the right to recover the excess
from other responsible persons within the company. To facilitate
this collection procedure, the person may obtain from the IRS
the name of any other person it considers to be liable for the
penalty. The IRS must provide information as to whether it has
attempted to collect the penalty from that person, the nature
of the collection procedures, and the amount collected [IRC section
As a final
note, once a taxpayer is found to be liable for unpaid trust fund
taxes, avoidance of payment is virtually impossible. The U.S.
Supreme Court has ruled that the liability is nondischargeable
in bankruptcy proceedings [U.S. v. Sotelo, 78-1 USTC
para. 9446 (USSC, 1978)].
R. Fouch, PhD, CPA, is a professor of accounting in the
division of business and accountancy of Truman State University,